403(b) Outlook: Catch-Up Contributions

What is the rule? The maximum amount of elective deferrals that employees can contribute to a 403(b) or 401(k) plan in 2008 under IRC Section 402(g) is $15,500. (This amount is adjusted for inflation in $500 increments.) 403(b) vendors must take reasonable steps to help ensure that 403(b) elective deferrals made to their investment products do not exceed the Section 402(g) limit.

The 15-Year Rule allows employees to exceed the otherwise applicable 402(g) limit if they have at least 15 years of service with the same employer which is a qualifying tax-exempt organization — teaching institution, hospital, church, home health care organization, or health and welfare service agency. Under the 15-year catch-up, if an employee’s elective deferrals in prior years were less than the 402(g) limit, he or she may be able to make deferrals of up to $3,000 over the applicable 402(g) limit for the current year, subject to a lifetime limit of $15,000. This 15-year rule is available only under 403(b) plans (not 401(k) or 457(b) plans). This 15-year catch-up is in addition to the Age 50+ Catch-Up discussed below.

What has changed? The final regulations expand the definition of a health and welfare service agency. Currently, a health and welfare service agency is defined as an organization whose primary activity is to: (1) provide medical care (such as a hospice); (2) prevent cruelty to individuals or animals; or (3) provide substantial personal services to the needy. Effective 2009, this definition will be expanded to include agencies that provide: (1) adoption services; (2) home health services; (3) assistance to individuals with substance abuse problems; or (4) help to the disabled.

Age 50+ Catch-up Elective Deferrals: If the plan permits, employees age 50 and older can make additional elective deferrals to 403(b), 401(k), and public/governmental 457(b) plans. In 2008, the age 50+ catch-up amount is $5,000. These elective deferrals can exceed the statutory dollar limits otherwise imposed by the 415 or 402(g) limits, (but cannot exceed the 100% of compensation limit under Section 415). Age 50+ contributions are not subject to any other contribution limits (other than those mentioned above) or to any nondiscrimination rules. However, the plan must allow all plan-eligible employees age 50 and older to participate in the same manner. . Participants have one age 50+ catch-up for all 403(b) and 401(k) plans, if they participate in both types of plans. Participants eligible for both a 403(b) and a governmental 457(b) plan will have age 50+ catch-up opportunities available under both plans. An employee age 50 or older who is also eligible for the 15-year rule may be able to contribute up to $23,500 to a 403(b) plan in 2008 ($15,500 under 402(g), $3,000 under the 15-year rule, and another $5,000 in age 50+ catch-up contributions).

Elective Deferral Ordering Rule: The regulations clarify that if an employee is eligible for both the 15 year and age-50 catch-up, that the 15-year rule should be applied before the Age 50+ Catch-up. Additional details are available online.

What happens if employees fail to comply? If employees are permitted to make elective deferrals in excess of the 402(g) limit ($15,500 in 2008), the 403(b) contract may lose its tax-exempt status unless the excess deferrals are corrected in a timely manner, which is no later than April 15 of the year following the year in which the excess occurred. Furthermore, the employer may be responsible for any employment taxes and withholding that apply.

Even if the IRS determines that the contract is not disqualified, if excess deferrals are not corrected in a timely fashion, the employees whose elective deferrals exceed the 402(g) limit must report the excess deferral as income for the year in which the deferral was made as well as for the year when the excess amounts are withdrawn. To avoid double taxation, the excess amounts, plus earnings, must be refunded to them by the tax filing deadline for the year in which the contributions were made, for example, by April 15, 2009, for excess contributions made during calendar year 2008. In that case, the excess deferral need only be reported as taxable income for the year the contribution was made. Refunded earnings attributable to an excess deferral will be reported as income in the year refunded; losses attributable to an excess deferral can reduce reported income in the refund year.

How TIAA-CREF helps: To help plan administrators monitor employees' compliance with the 402(g) limit, TIAA-CREF conducts a year-end review of employee deferrals that have been applied to each plan participant's account during the calendar year. If employee deferrals in any plan exceed the 402(g) limit, we will notify you by letter, usually by mid-January following the close of the calendar year in question. Included in this letter will be a list of plan participants who, according to our records when viewed on a per-plan basis, have exceeded the 402(g) limit. Once you confirm which plan participants have exceeded the 402(g) limit and the amount by which the limit is exceeded, we will refund the specified amount. And we provide the appropriate tax reporting to the participants and the Internal Revenue Service. To help prevent excess deferrals, employees may also request TIAA-CREF to help them calculate the maximum 402(g) amount they can defer in any given year.